I am a senior editor at Forbes, covering legal affairs, corporate finance, macroeconomics and the occasional sailing story. I was the Southwest Bureau manager for Forbes in Houston from 1999 to 2003, when I returned home to Connecticut for a Knight fellowship at Yale Law School. Before that I worked for Bloomberg Business News in Houston and the late, great Dallas Times Herald and Houston Post. While I am a Chartered Financial Analyst and have a year of law school under my belt, most of what I know about financial journalism, I learned in Texas.

With Autonomy, H-P Bought An Old-Fashioned Accounting Scandal. Here's How It Worked.

The story was first told to me late last year, and like a lot of stories of financial impropriety inside a huge company, it was almost impossible to nail down. Hewlett-Packard‘s Autonomy division, my source told me, was vaporware writ large: An $11 billion software company with an overhyped flagship product that was literally being given away because customers didn’t have a use for it.

In the release, H-P identified one of the oldest accounting tricks in the book, a variation on the one “Chainsaw Al” Dunlap used to accelerate revenue at Sunbeam — by getting customers to “buy” products now, under terms that really just borrowed from the future.

I spoke to my source again this morning and he detailed what he saw at H-P, from his position deep within the 300,000-employee company.

“What I saw was exactly what Meg Whitman wrote in her internal memo to employees,” my source said. “There was really sketchy accounting going on.”

Autonomy was founded as Cambridge Neurodynamics in 1991 by Michael Lynch, a Cambridge-educated computer scientist, according to this flattering profile by the Guardian after he left H-P in May. The company was based on the then-hot concept of Bayesian search, named after 18th-century mathematician Thomas Bayes, and ultimately developed an all-encompassing software package it called IDOL — Intelligent Data Operating Layer.

H-P today said it stands behind IDOL and well it should. Otherwise it would have to write off the entire $11 billion it paid for Autonomy last year. But my source doesn’t think much of the product, which is supposed to find all of a company’s data, wherever it resides, and whether or not it can be identified by specific words. (Typical example: Finding documents that contain the phrase “flightless bird” when you’re looking for “penguin.”)

“It’s the primary smoke and mirrors that Autonomy has used to make people think they’ve got something very impressive,” he told me. “It’s a fancy search engine.”

I attempted to reach Lynch this morning, unsuccessfully. His spokeswoman told Reuters he is still reviewing H-P’s allegations. H-P said it has referred the information it uncovered in a forensic accounting to fraud officials in the U.S. and the U.K.

Here’s what my source observed personally. Autonomy grew through acquisitions, buying everything from storage companies like Iron Mountain to enterprise software firms like Interwoven. They’d then go to customers and offer them a deal they couldn’t refuse. Say a customer had $5 million and four years left on a data-storage contract, or “disk,” in the trade. Autonomy would offer them, say, the same amount of storage for $4 million but structure it as a $3 million purchase of IDOL software, paid for up front, and $1 million worth of disk. The software sales dropped to the bottom line and burnished Autonomy’s reputation for being a fast-growing, cutting-edge software company a la Oracle, while the revenue actually came from the low-margin, commodity storage business.

“They would basically give them software for free but shift the costs around to make it look like they got $3 million in software sales,” said my source, who directly observed such deals.

Lynch’s management team also was practiced at the art of wringing attractive-looking growth out of a string of ho-hum acquisitions. The typical strategy was to bolt IDOL and other software onto a company’s existing products and try and convince customers to pay more for the “new” products. If that failed, they’d milk the existing customer base by halting development and outsourcing support, my source says, using the cash from the runoff business to fund more acquisitions.

“Mike Lynch was famous for saying Autonomy never put an end of life on any product,” said my source. “But the customers were screaming.”

Now, my source has never been a Mike Lynch fan. In sales meetings, he says, Lynch “loved to do vague and theoretical academic-type presentations to show what a visionary he was.”

And Autonomy may have some powerful features my source didn’t appreciate. The Defense Department reportedly is a customer. But from his perch within the company, it looked like a lot of vaporware wrapped up in fancy Cambridge talk and the kind of accounting tricks managers have engaged in since the dawn of publicly traded stock.

With its announcement today, H-P seems to agree. The company accused former managers of “a willful effort” “to inflate the underlying financial metrics of the company in order to mislead investors and potential buyers. These misrepresentations and lack of disclosure severely impacted HP management’s ability to fairly value Autonomy at the time of the deal.”

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Sound to me like the real problem is that HP did not do proper due Diligence on the deal, how hard is it to pick up a phone and talk to a CEO of one or a few of autonomy customers, if customers were really screaming at autonomy, I am sure one or more of them would have spoken up in confident to HP.

An all management and company founders hype up the value of their companies. I suspect Autonomy and the managers will be found clear and this is just HP way to write of its tax obligations for the next couple of year and trying to gain public sympathy why it at it.

Autonomy was always known inside IT circles as just a fancy search engine (HP is part of this IT circle and should have known this), with a few other bells and whistles, they even tried to take on Google in the consumer search business a few year back and was rumoured to be planning a second go at the consumer market before HP took over.

You think a CEO’s going to stand up and say, “Hey, that product we paid quadzillions for is a piece of dog-retch, and I’m a dang fool to have ever allowed this to go forward!”. Not gonna happen! First off, if it’s a big enough company to have bought this schlock in the first place he’s not going to know from garbanzo beans about one particular chunk of technology. He’s gonna have his head in the clouds, “thinking strategically”,etc, and the “how the hell’r'we gonna actually DO this” isn’t in his sights. *If* he got such a call he’d refer it to the Senior VP of Information Technology, who *might* know that this software was a pile of dreck, but *he* ain’t gonna say that because he’s supposed to be a Smart Boy (or Girl) who doesn’t make such mistakes. So *he* (*she*/*it*) is going to bump it down the road the the Vice President of New Development, who likewise ain’t gonna take the hit (plausible deniability and all that), so now you’re down to the Director of Application Development who either A) knows it’s junk but can’t stab their VP in the back, B) thinks it’s wonderful because he/she/it doesn’t know crap, or C) really *doesn’t* know (remember, he/she/it is a VP-wannabee and has hopefully learned how to avoid knowing things he/she/it should be able to deny) and so NOW you’re gonna get bumped down to a Project Manager who’s gonna know full well how you got to them and is going to tell you, “Sure, great stuff, works fantastic, we’re excited about it, hey, gotta meeting, gotta run, BYE!”. Basically, don’t count on someone else to do your Due Diligence for you – which, apparently, HP did.

This is interesting because of this statement by Meg W. She added that one of the issues during the Autonomy deal was that the due diligence department reported up to the chief strategy officer at HP, which was Robison at the time, not to the chief financial officer – something that she rectified as soon as she took over as CEO.

I can’t comment on Autonomy’s status as vaporware, but you’re correct that in the corporate world, where software is a bastard step-child that is often seen as THE problem rather than THE solution, it would be unheard-of for anyone to admit to paying millions for non-functional software. Corporate tech execs are supposed to be canny enough to avoid such disasters, and when they happen heads can roll. More likely is that a test project using the software would be launched, and if/when problems turned up further use of the software in question would be “back-burnered”, so that the execs in question could justifiably say that “…further use of that product is planned but has been temporarily put on hold due to more pressing concerns” – like, say, walking the CEO’s dog, or cleaning the executive toilets – basically ANYTHING! Then, once all the gloss-and-shine is forgotten the product can be ignored until the next re-org comes along and all memory of it conveniently vanishes into the belly of the corporate beast, never to be heard from again.